Due Diligence: Follow The Bits

Offshore IT services companies are upping the stakes on quality and timeliness, not just cost savings, writes Eric Nee. That's good for CIOs, bad indeed for U.S. IT services firms.

My wife and I went shopping for a new car recently at a Toyota dealership in Palo Alto, Calif. A downcast man in his mid-fifties who had just been laid off from his IT job at a restaurant chain came out to wait on us. He was the kind of guy who clearly felt more comfortable interacting with machines than with people.

It was sad to see someone so far out of his realm. What was even sadder was that there is a good chance this man will never work in the IT industry again. That's because IT services jobs like the one our salesman had are fast migrating overseas, to India, China and other countries, never to return again.

Programming jobs began moving to low-wage countries some years ago, but until recently the numbers were few and the tasks were mostly low-level. In the past few years the trickle has become a flood, as the heightened desire of U.S. companies to outsource IT has been matched by the growing sophistication of overseas firms.

What is occurring in the IT services business is disquietingly similar to what's been happening over the course of the past few decades, as millions of manufacturing jobs moved overseas. Only this time it's white-collar jobs in Silicon Valley that are taking flight, not blue-collar jobs in Detroit.

As many as 20 percent of all IT services jobs will leave the U.S. over the next dozen years, predicts John McCarthy, group director at Forrester Research in Cambridge, Mass. As alarming as that number is, it could prove to be too conservative.

IT services jobs are all about managing and manipulating bits. Fiber-optic networks and the Internet make it possible for people halfway around the world to write and ship code, manage a network, and answer queries as easily as if they were across town. That means many IT jobs now located in high-wage areas in the U.S. look like prime targets to move elsewhere.

But the exodus of IT jobs might be even greater than it was in the manufacturing sector. Here's why: The cost of shipping manufactured goods can sometimes exceed the savings gained by moving jobs to low-wage countries, making it impractical to locate factories too far from the customer. Bits, however, have no shipping cost.

As U.S. business increasingly turns to outsourcing as a way to cut IT costs and concentrate internal efforts on more strategic functions, overseas firms are more often getting the nod. The world's fastest growing IT services providers today are Indian firms such as Infosys Technologies, Wipro, Satyam Computer Services, Larsen & Toubro Infotech and 24/7 Customer. They may not be household names yet, but they will be.

Infosys, one of India's largest IT services providers, reported a 45 percent jump in revenues, to $200 million, for the quarter ended December 2002. Infosys started with small-time contracts, but today the company handles dozens of major IT tasks for large multinational firms. It recently installed an Oracle financial package for the clothing retailer Nordstrom Inc., developed a Web-based customer interface for Franklin Templeton Investments, and continues to manage legacy applications for The Burlington Northern and Santa Fe Railway Co.

The bulk of the work done by India's firms today is in application maintenance and custom application development. But more and more U.S. firms are turning over other IT services to these firms, including systems administration and support, packaged application implementation, systems analysis and architecture planning, and infrastructure outsourcing.

U.S. IT services providers have taken note. Their immediate response has been to announce plans to move jobs overseas in hopes of cutting costs. Last fall, Electronic Data Services launched what it calls its "Best Shore" program, setting up IT service centers around the world. "We tell our clients, 'Let us help you use India as a hub, and further leverage that into multiple countries,'" said EDS CEO Richard Brown at the company's December 2002 analyst meeting.

Hewlett-Packard is following suit. Ann Livermore, executive vice president of Hewlett-Packard Services, said at her company's December 2002 analyst meeting that H-P already had several thousand service employees in India, and planned to add many more. "We think customers are going to put a lot of pricing pressure on the consulting and integration market," Livermore was quoted on News.com as saying. "We are going to aggressively move everything we can offshore."

"The Indians have emerged as a credible offshore threat, and the traditional U.S. firms have been forced to react," says Forrester's McCarthy.

The immediate effect of the growth of offshore IT services has been to push prices down across the globe. "It's having a deflationary impact on IT services," says McCarthy. The cost of an entry-level programmer in China is 30 percent to 50 percent less than one in Chicago, London or Tokyo, according to Forrester. The savings to be gained by going offshore for less skilled IT services jobs, such as call-center workers, are even greater.

And with CIOs being asked to squeeze costs, the cost advantage of overseas outsourcing is proving to be more and more attractive. In a recent Forrester survey of 145 large North American businesses, 30 percent said they had used offshore IT service providers in 2002, or planned to do so in 2003. That leaves 70 percent who aren't going offshoreyet.